Small Business Questions & Answers

Filed under Start Up

Ask About Organizing a Nonprofit

by Committee of One | May 24, 2012

Subject :Business Entities and Not-for-Profits

Dear Toolkit,

I just got elected to the board of a new little not-for-profit group here in town, and I'm supposed to get us registered as a "tax exempt 501(c) entity" (whatever that is) so that folks can deduct their contributions to us. How do I go about this? Is it something I can do myself? Or should I have the lawyer I use for my small business stuff do this?

Committee of One

Dear Committee,

If I were you, I'd have my lawyer do this from the get-go. The first step in creating an exempt entity is to incorporate as a nonprofit in your state. Filing articles of incorporation with your secretary of state will create the entity and its inherent limited liability benefit. The next step is to file an Application for Exemption with the IRS--and be prepared to pay the sometimes-significant user fees for this privilege. Also be prepared to wait--and wait--and wait.

Be aware that there are dozens of types of "tax exempt entities." Be sure your lawyer chooses the right one. While most are excluded from having to pay federal income tax themselves, many of them do not qualify for the status that allows contributions to be deductible for their donors.

As you pointed out in your query, the overall Revenue Code section dealing with exempt organizations goes by the elegant name of 501(c). The most desirable subsection for a budding nonprofit group to aspire to is a 501(c)(3). If your group is, for example, a religious, charitable, educational or scientific organization such as a nonprofit old-age home, a parent-teacher association, a school, a chapter of the Red Cross or a church, and if it can meet the stringent requirements to qualify as a 501(c)(3), your donors will have it made in the shade.

But the definitions for 501(c)s get a little dicey. To start with, there is subsection 501(c)(1), which covers "corporations organized under an Act of Congress" such as a federal credit bureau. A subsection 501(c)(2) entity is a corporation holding title to property of an exempt organization. I suppose that could be the land under a YMCA or a boat belonging to a Sea Scout troop, but don't quote me on that. 501(c)(4) entities would be "civic leagues" for the promotion of community welfare, such as a volunteer fire department.

Moving right along we find 501(c)(5)s--labor organizations--and 501(c)(6)s--"business leagues" like Chambers of Commerce. Payments to a 501(c)(6), for example, would not be deductible as charitable contributions, but would likely be deductible as a trade or business expense (Chamber dues) necessary to the conduct of the taxpayer's business.

The list of 501(c)s continues. . .from the ridiculous to the sublime: a 501(c)(13) is a cemetery company; a 501(c)(21) is a Black Lung benefits trust; a 501(c)(23) is for veterans' organizations formed before 1880.

You can learn more than you ever wanted to know about Section 501(c) of our Internal Revenue Code by going to IRS Publication 557. Good luck with your budding not-for-profit.